Five Takeaways on 2017 A/E M&A Activity

With the country in transition settling into the dynamics and drama of a new administration, the underlying positive momentum of both the U.S. economy and A/E industry has certainly been significant. At a macro level, we’ve seen this unfold with a soaring stock market, back-to-back quarters of 3%+ GDP growth and a plunging unemployment rate. And while unleashing a major U.S. infrastructure package was not in the political cards this year, A/E executives seemed not to notice. Backlogs are up across major client sectors, hiring needs are as acute as ever, recent setbacks in oil & gas and mining activity have abated, spending on capital equipment and software has risen, and A/E consolidation rolls along. As validation, new private equity investment into a number of the industry’s most recognizable and blue-chip A/E and environmental organizations was evident.

With better visibility, at least in the short-run, growth-oriented leaders have ramped up their M&A pursuits while potential sellers have felt increasing emboldened, highlighting their healthier financial performance and overall sanguine outlook. By our research, the number of 2017 North American A/E and environmental consulting transactions will finish the year generally flat from 2016 levels. However, we feel the size and scale of activity are poised to break out in 2018, primarily driven by a massive generation of Baby Boomer owners still woefully unprepared to successfully transition their firms and unlock value for themselves.

Key A/E M&A takeaways include the following:

1. The CH2M-Jacobs merger solidifies a new global echelon of players – Many were stunned in August to hear that two of the industry’s largest and iconic names had joined forces in a $2.8 billion merger with 75,000 employees worldwide. But in fact, this combination just reinforces the incarnation of an elite number of multi-disciplined organizations, working seamlessly across markets and borders. If I had told you four years ago that CH2M, URS, AMEC, MWH Global and Atkins would all be absorbed by other global consolidators, I imagine most would have never believed it. Understandably, these tie-ups have now created deeper conversations in the boardrooms and executive suites of other sizable consulting firms. Will others be able to “go it alone” given their own size, strategic, succession and ownership/capital limitations?

2. Confidence fuels deal making – The two most critical elements needed to spur M&A activity are healthy balance sheets and executive confidence, and our industry has both today. The ACEC Engineering Business Index just reported its largest-ever quarterly increase, the AIA Billings Index has been elevated all year due to strength in inquiries and new design contracts, and the NFIB Index of Small Business Optimism remains high given owner expectations of stronger revenue, regulatory relief and expansion needs. With recruiting challenges everywhere as a limiting factor to growth, the “buy vs. build” calculus has shifted. CEOs have increasingly added synergistic acquisitions as an integral part of 2018 business plans.

3. But prosperity breeds complacency – Sadly, good times don’t last forever. While we’re currently experiencing a period of optimism and good fortunes, industry leaders need to be on alert for warning signs on the horizon. The Fed is set to raise interest rates. Markets are overheating in certain sectors (commercial, office, multifamily and lodging construction across numerous cities). More states faced mid-year revenue shortfalls in the last fiscal year than in any year since 2010. Higher wages needed to attract and retain architects and engineers risk profit margins unless productivity and utilization levels can be increased. Many owners kick the can down the road on succession planning and exit strategy thinking for another time as flush bonuses and distributions paralyze decision making.

In the context of M&A activity, buyer complacency emerges in lacking the proper valuation, due diligence, risk assessment and integration discipline. Elements of mature cycle M&A engagement often include assessing “hockey stick” financial results of targets over the last 12-18 months (is it sustainable or representative?), the increased desire of earnouts to mitigate downside risks, and contemplating future cost savings or staff redundancies should a target firm’s results suddenly decline.

4. M&A convergence of A/E professional services with technological assets – As our industry enters the 21st century, rapid scientific and technical advancements are creating exciting and revolutionary design changes in buildings, ITS/highways, power grids, energy systems, data centers and telecommunication networks, to name a few. As a result, we are witnessing an intersection of traditional A/E firms acquiring companies with unique hardware, software and product-related synergies. Great examples this year included targets specializing in: 1) data analytics for utilities; 2) water infrastructure software and modeling; 3) EHS enterprise technology and IT services; 4) advanced control systems for smart cities and industrial automation; and 5) geospatial firms with proprietary GIS/mapping software and unmanned aircraft systems.

5. The taxman cometh – While the new tax bill still has to be reconciled and finalized, to say that architecture and engineering leaders are disappointed with the changes coming out of Washington would be an understatement. Pass-through S-Corporations, which comprise the majority of A/E firms, would be excluded from lower rates compared to other businesses. We are already seeing owners crunch the numbers and assess their options, including taking a serious look at C-Corporation conversion, particularly if their firms might lose Section 199/DPAD deductions and are negatively impacted (personally) by reduced state and local tax (SALT) deductions.

Dave Sullivan, National A/E Tax and Advisory Partner at the Boston-based firm DiCicco, Gulman & Company does not see a negative impact on future M&A activity with this proposed law. However, he also does not see anything that would necessarily accelerate it. For sellers, capital gain rate changes are not on the table, and although there is limited clarity on where ordinary income rates will ultimately fall, they do not appear to be rising. For acquirers purchasing assets, there may be accelerated deductions available that would create additional cash flow during the post-transaction period. We’ll have to see where the dust settles with all of this heading into next year.

At ROG + Partners, we possess strong relationships and years of experience navigating A/E and environmental buyers and sellers through the M&A process and towards winning combinations. Whether you are seeking to grow through acquisitions or by evaluating your firm’s strategic and ownership alternatives, please contact us as to how we can help your organization.

On a final note, Season’s Greetings and a happy, healthy and prosperous New Year from all of us here at ROG + Partners!

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About the Author

Steve Gido specializes in corporate financial advisory services with a focus on mergers and acquisitions. Steve has assisted architecture, engineering, environmental consulting and construction firms of all sizes across North America achieve their growth or liquidity goals through successful mergers & acquisitions. Steve has over 15 years of investment banking experience and holds the chartered financial analyst (CFA) designation from the CFA Institute.